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Malas Notches

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  • Lockwood, Ben

    (CBT, CEPR and University of Warwick)

Abstract

This paper shows that the sufficient statistic approach to the welfare properties of income (and other) taxes does not easily extend to tax systems with notches, because with notches, changes in bunching induced by changes in tax rates have a first-order effect on tax revenues. In an income tax setting, we show that the marginal excess burden (MEB) of a change in the top rate of tax is given by the Feldstein (1999) formula for the MEB of a proportional tax, plus a correction term. These correction terms cannot be calculated just from knowledge of the elasticity of taxable income and quantitatively, they can be large. An application to VAT is discussed; with a calibration to UK data, the MEB of the VAT is roughly three times what is would be if VAT was simply a proportional tax.

Suggested Citation

  • Lockwood, Ben, 2019. "Malas Notches," The Warwick Economics Research Paper Series (TWERPS) 1206, University of Warwick, Department of Economics.
    • Handle: RePEc:wrk:warwec:1206
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    References listed on IDEAS

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    More about this item

    Keywords

    tax kink ; tax notch ; excess burden ; sufficient statistic;
    All these keywords.

    JEL classification:

    • H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H31 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Household

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